Question

A special purpose vehicle (SPV) has been incorporated to undertake an energy infrastructure project in a country with a gross national income (GNI) per capita of US$1,000. Explain four key categories of risks which the SPV is likely to encounter in undertaking the project.

Answer 1

Benefits and risks of creating SPV:

Establishing an SPV can bring important benefits for the parent company. However, this process is not without risks.

 

Main benefits:

• Isolation of financial risk: by establishing a SPV as an ‘orphan company’ and transferring some assets, such SPV assets are insolvency remote in the event of bankruptcy or default by the parent company.
• Single asset ownership: a SPV allows the ownership of one asset by multiple parties
• Legal protection: by structuring a SPV, the parent company limits the legal liability in case of a failure of the SPV’s project
• Minimal red tape: setting-up a SPV is relatively easy and cheap, depending on the choice of jurisdiction. Generally, no governmental authorization is required.
• Tax benefits: SPV’s assets can be exempted from certain direct taxes.

 

Main risks:

• Complexity/lack of transparency: the complexity of SPVs can make the monitoring of the level of risk involved and who it lies with really difficult.
• Reputational risk: the parent company’s perceived credit quality may be damaged by the underperformance or default of an affiliated SPV.
• Liquidity/funding risk: the poor performance of an affiliated SPV can affect the parent company’s access to capital markets
• Regulatory risk: regulatory standards that applies to SPV’s assets is not the same as to the parent company’s assets on balance sheet. This lax regulation can pose an indirect risk to the parent company.